Question 1: Suppose you have recently been contracted as a financial consultant to a London-based engineering company, Alpha Products Plc. The company uses three components as part of their production process, namely, A, B and C. The budgeted production output for the forthcoming year is to produce 10,000 of each of the three components.
The variable production cost per unit of the final product is as follows:
Machine hours Variable cost £
1 unit of A 6 65
1 unit of B 4 90
1 unit of C 8 60
Assembly 50
Total 265
Only 112,000 hours of machine time will be available during the year, and a sub-contractor has quoted the following unit prices for supplying the three components: A £72.50; B £100 and C £88.
Required: Write a short report, intended for CEO of Alpha Products Plc, William Smith, who is not an accountant, advising him of the following:
(a) Using the above financial data provide calculations which support your advice to the company on whether it should produce the three components or outsource them.
(b) Explain the use of the principle of opportunity cost and why cost minimisation and profit maximisation are compatible concepts and include a table showing the total variable cost of your selected production or purchasing plan.
(c) Critically discuss the practice of outsourcing and the problems you consider may be associated with this practice.
(d) Structure and presentation of the report
Question 2 :
Part B: Methods of Overhead Allocation
A manufacturing company, based in Birmingham, makes auto parts for the motor industry. A division of the company makes two engine components, X and Y. Relevant information on the next budget period for these two components are given below:
Product parts X Y
Output in units: 13,000 15,000
Cost per unit:
Direct material £45 £55
Direct labour £30 £25
Total machine hours 2,500 2,300
Number of production runs 65 75
Orders executed 135 145
Number of shipments 40 35
The two components are similar and are usually produced in production runs of 200 units. The production overhead is currently absorbed by using a machine hour rate, and the total of the production overhead for the period has been analysed as follows:
Overhead Budgeted cost £ Cost Driver
Machine department costs £360,000 machine hours
Set-up costs £99,400 Number of production runs
Inspection/Quality control £25,900 Number of production runs
Material handling £156,800 Orders executed
Delivery £26,250 Number of shipments
£668,350
Required: (a) Using the Activity Based Cost information, compare the overhead cost per unit in £ and the percentages of overhead costs for the two parts, X and Y.
(b) Using the number of units to assign overhead costs to the parts, X and Y, (a traditional approach) compare the overhead cost per unit in £s and the percentages of overhead costs allocated for the two parts.
(c) Using the data available, explain the differences between the unit overhead costs in percentages between (a) and (b) above.
(d) Discuss the advantages and disadvantages of organisational decentralisation.